price war

price war

a situation of aggressive price cutting by a group of rival suppliers as a means of gaining sales at each other's expense. Since price wars, however, tend to be mutually ruinous by destroying the profitability of the market, they are normally avoided, with suppliers preferring to compete instead through various PRODUCT DIFFERENTIATION strategies. See OLIGOPOLY, CARTEL, COLLUSION, PRICE LEADERSHIP.

price war

any competition between rival suppliers centred on aggressive PRICE cutting. Price wars often break out when demand for a product is depressed and there is EXCESS SUPPLY capacity in the market. If FIXED COSTS are a high proportion of total costs, suppliers may be tempted to cut their prices to maintain full capacity working.

Price warfare is beneficial to the consumer and to RESOURCE ALLOCATION within the market insofar as it serves to eliminate inefficient, high-cost suppliers. The problem from the suppliers’ point of view is that cut- throat price competition reduces the profitability of the market and everybody finishes up worse off. For this reason, suppliers, particularly OLIGOPOLY suppliers, will normally try to avoid price wars and direct their competitive efforts into PRODUCT DIFFERENTIATION activities. See COMPETITION METHODS, PRICE LEADERSHIP.

Low production costs will determine the ability to wage the kind of bitter price wars that detonated early last year when both companies offered retail discounts of up to 50%, compared with zero to 5% normally At one point, a 2-liter bottle of soda cost as little as 80 cents.

Klemperer (1989) and Elzinga and Mills (1998) use discrete-time dynamic models to explore the theory of price wars triggered by entry and show that customer switching costs can produce the sequence of events just described.

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